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September 21, 2011

Fed Tackles Long-Term Rates to Spur Economy

‘Operation Twist,’ intended to bend the yield curve, announced as expected

A NYSE trader watches a monitor after end of Ben Bernanke's speech in August. (Photo:AP)

Federal Reserve policymakers announced Wednesday that they would buy $400 billion of longer-term U.S. Treasury securities to put downward pressure on longer-term interest rates and “help make broader financial conditions more accommodative.”

Commonly known as “Operation Twist,” the Fed’s goal is to bend the yield curve to keep interest rates lower and thus encourage more job creation for the ailing U.S. economy. Analysts had anticipated such a move from the Fed as rates remain low and policymakers have fewer monetary policy tools to use.

In the Federal Open Market Committee’s announcement, the policymakers specified that by the end of June 2012, the FOMC intends to purchase $400 billion of Treasury securities with remaining maturities of six years to 30 years and to sell an equal amount of Treasury securities with remaining maturities of three years or less.

Ian Shepherdson, chief U.S. economist for High Frequency Economics Ltd., in Valhalla, N.Y., said in an analyst's note that the attempt to flatten the curve has been triggered by significant downside risks, including strains in global markets, while inflation is expected to settle soon despite the recent surge in core prices.

However, Shepherdson was skeptical that Fed Chairman Ben Bernanke or his policy-making board can have much effect on the economy at this point.

“We expect the Fed's actions to have very little visible effect on the economy, because the level of interest rates and the shape of the curve are not the key constraints on growth. Mr. Bernanke wants to be seen to be doing something, but his hand is not on the fiscal policy lever,” Shepherdson said.

To help support conditions in mortgage markets, the FOMC also announced it would reinvest principal payments from its holdings of agency debt and mortgage-backed securities into agency mortgage-backed securities. In addition, it will maintain its existing policy of rolling over maturing Treasury securities at auction.

The Fed acknowledged that economic growth has remained slow since the FOMC last met in August.

“Recent indicators point to continuing weakness in overall labor market conditions, and the unemployment rate remains elevated. Household spending has been increasing at only a modest pace in recent months despite some recovery in sales of motor vehicles as supply-chain disruptions eased. Investment in nonresidential structures is still weak, and the housing sector remains depressed,” the Fed said.

Doug Roberts, chief investment strategist for ChannelCapitalResearch.com, Shrewsbury, N.J., said in an interview with AdvisorOne that the Fed’s move on Wednesday was “pretty much status quo”—a continuation of easy monetary policy—that was already factored into the market.

“You’ll notice the market was a little bit down,” Roberts said. “They figured it would be Operation Twist. The only additional thing the Fed added today was the reinvestment of the mortgage-backed portfolio. So we saw no difference in size, no foreshadowing of the future except for the vague statement that was in there before, which is that they have other tools, and if necessary, they will utilize them.”

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